Contract Costing of Construction Industry

The costing method that is commonly practiced by construction industry is contract costing. Contract costing is a technique that is used to track the cost of a specific contract with a specific customer. When two parties enter into a contract, for example, a construction company enter to a contract with their client, they will have to agree on some terms of the contract and one of the most important term is the type of reimbursement to the construction company. There are few types of reimbursement and they are normally based on the cost that is incurred by the construction company. The construction company must be able to track the cost that is related to the contract so that they can justify their billings to the client. (Contract Costing: Accounting Tools, 2011)

There are few common types of contract costing with different reimbursement method which are fixed price/lump sum contract, cost plus contract, time and material contract and also unit pricing contract. (Rodriguez, 4 Common Types of Construction Contracts: The Balance, 2017)

Under fixed price/lump sum contract, two parties will need to agree on a lump sum price before all the works begin and the contractor will need to submit a total price for their project. This costing method estimates material cost, labour cost plus a calculated amount of money that is expected to cover all of the contractor’s overhead and profit margin. However, this contract is not secured for the contractor as the price is fixed and they could have incurred more cost than the price they agreed upon. In a fixed price contract, the client will transfer all the risk to the contractor as they are responsible for proper job execution by using their own means under this contract. However, the contractor can ask for higher return as they are the one who bear all the risks. This costing method is recommended for favourable and stable condition projects. (Rodriguez, Learn About Lump Sum Construction Contracts: The Balance, 2017)

For cost plus contract, the client will pay the contractor all the related expenses that are agreed upon the contract plus an amount of profit for the contractor. Unlike fixed price contract, this contract makes contractor better off as they are more likely to recover all their expenses and risks. They are not required to submit an estimate of the full cost before they start the job and they can receive continuous reimbursement from the client. Some of the client will set a limit to avoid the contractor to be overspending on the construction cost. This contract is suitable for situation with uncertainties. (Rodriguez, Construction Contracting: All About Cost-Plus Contract: The Balance, 2017)

Under time and material contract, the contractor is paid based on cost of direct labour and direct materials used plus an amount that cover the contractor’s overhead and profit. (Time and Materials (T&M) Contract: Business Dictionary, n.d.) For time and material contract, the pay rate for all the labour and personnel are specified and it typically add a mark-up ranging from 15 to 35 percent on the material used. This contract is the most secure contract for the contractor with the customer bear almost all of the risk. It is only recommended for projects that are unable to perform an accurate estimate and the project scope cannot be defined. In order to protect the customer, they will set a maximum amount which the contractor can charge and also maximum labour hours they can use to optimize contractor’s efficiency. (Rodriguez, Time and Materials Contracts: The Balance, 2017)

Under unit price contract, past history and current condition of the asset being maintained are used to estimate the work when they are establishing this contract. With this estimation figure, the contractors are provided with more accurate estimation of work and the basis of how they are going to be paid. However, this estimated figure is not the full price for the contract and the full price of the contract is the amount incurred after all work has been done. Unit price contract use estimated quantities of items and unit prices of items such as hourly rate or rate per unit work volume as basis of estimating the cost of a project. This contract is recommended to use when the quantities cannot be estimated accurately before the construction project starts. It is also suitable for business that are reoccurring. (Unit Price Contracts: Government of the Northwest Territories, 2009) Job Costing of Service Industry

Job costing is a technique of accumulating all of the information of cost such as the cost of materials, labour and overhead for a specific job. This information is useful for a service firm as this information will be presented to the customer under the contract so that their customer are acknowledged of how many cost this job will incur. In addition, the precision of the company’s estimating system can also be ascertained as this system plays an important system in quoting a reasonable price for the customer. There are three main types of information that a job costing method should include which are direct materials, direct labour and overhead. (The job costing system: Accounting Tools, 2015)

Some of the service company track direct materials for each job while some did not. For instance, accountants or lawyers use binders and paper when they are providing their service. However, these costs are not going to be include in direct materials as the value of these materials are too insignificant. These materials are known as supplies and are often treated as overhead instead of direct material cost. For some service company, the costs of material are more considerable and they will track the cost of direct material for each job. For these service company, these materials are significant in conducting the business. For instance, for a car mechanic, who needed the spare parts of vehicles in performing repair service will track the cost of these direct materials for each job performed. (Job Costing in Service Organizations: Saylordotorg, n.d.)

For some of the service company, direct labour cost might cover major of the job cost. In order to assign direct labour to a job, there are few methods that are used by the service company which include using timecard, timesheet or networked time clock application. Through this, they can trace the labour cost incurred as all the working hours of the staff are recorded for each job. (The job costing system: Accounting Tools, 2015)

Overhead are assigned to one or more cost pool and it will charge to each of the job when it comes to the ending of accounting period. These overhead costs are assigned to each job based on certain cost driver. The cost driver for overhead in service industry is often the direct labour hour or direct labour cost. Hence, most of the overhead are assigned to each job based on the direct labour hours used or direct labour cost incurred for the specific job. (The job costing system: Accounting Tools, 2015)

Job costing system need to be customized for some of the customer in order to meet their requirements as some of the customers will set limit for cost to be charged on the job. Eventually, job costing system is not generally appropriate to all the jobs as they might comprise of a lot of specialized rules. The company must close down the job in job costing system when the job is completed or the employee might continue to charge time to the job and it will add cost to the job subsequently.

Supposing that the job is processing, the compiled cost of the job should be treated as inventory asset. This inventory asset will then transfer to cost of good sold account when the job is billed to customer or is written off. (The job costing system: Accounting Tools, 2015)